National Bureau of Economic Research
October 2012
Cost Effectiveness Analysis and the Design of Cost-Sharing in Insurance:
Solving a Puzzle
By Mark Pauly

Abstract
The conventional model for the use of cost effectiveness analysis for
health programs involves determining whether the cost per unit of
effectiveness of the program is better than some socially determined
maximum acceptable cost per unit of effectiveness. If a program is
better, the policy implication is that it should be implemented by full
coverage of its cost by insurance; if not, no coverage should be
provided and the program should not be implemented. This paper examines
the unanswered question of how cost effectiveness analysis should be
performed and interpreted when insurance coverage can involve
non-negligible cost sharing. It explores both the question of how cost
effectiveness is affected by the presence of cost sharing, and the more
fundamental question of cost effectiveness when cost sharing is itself
set at the cost effective level. Both a benchmark model where only
"societal" preferences (embodied in a threshold value of dollars per
unit of health) matter and a model where individual willingness to pay
can be combined with societal values are considered. A common view that
cost sharing should vary inversely with program cost effectiveness is
shown to be incorrect. A key issue in correct analysis is whether there
is heterogeneity either in marginal effectiveness of care or marginal
values of care that cannot be perceived by the social planner but is
known by the demander. The cost effectiveness of a program is shown to
depend upon the level of cost sharing; it is possible that some programs
that would fail the social test at both zero coverage and full coverage
will be acceptable with positive cost sharing. Combining individual and
social preferences affects both the choice of programs and the extent of
cost sharing.

From the Introduction

Of course, the answer to the question of the relationship between cost
effectiveness values and cost sharing depends both on the perspective
taken and the empirical facts. So I first outline the simple and
correct application of a decision rule to treatment choices based on
cost effectiveness in the "binary coverage" setting, when insurance
either covers 100 percent of the cost of a given type of care or leaves
it entirely uncovered, and the extra welfarist approach is taken. I
show that this approach usually is based on two assumptions: a single
value for expected improvement in health outcomes is to be applied to
all patients, and a single monetary value for those expected marginal
benefits prevails. This is the approach, avowedly "extra-welfarist,"
much favored at present in the United Kingdom by the NICE advisory body.

However, I then show that opening the door to consideration of cost
sharing means that many things, including this perspective, might
appropriately be modified. Modifications are needed if there is
heterogeneity in either effectiveness of the treatment across patients
or in the values citizens place on health outcomes, and that
heterogeneity is determined to be relevant to policy. I show that the
ideal level of "interior" cost sharing depends on whether consumer
values are assumed to be relevant, on how much consumer values really
vary, and most especially on whether the extent of variation in expected
effectiveness across patients is perceived by patients but cannot be
known by the insurer. I briefly consider as well the possibility that
social values are variable or uncertain.

Conclusion
These are somewhat discouraging conclusions. They definitely imply that
there is no simple but correct way to move from findings of a typical
cost effectiveness study to saying what the coinsurance rate should be
for a non-poor population. The most one could hope for would be a
binary decision of whether or not a particular treatment should or
should not be covered by insurance with a particular predetermined cost
sharing rate (usually but not necessarily zero). They also imply that
the cost effectiveness of a treatment cannot be properly determined
unless coinsurance is set at the optimal level. So, unless there is
perfect information to identify heterogeneity of benefits,
considerations of consumer demand (in the classic economic sense of the
shape of the demand curve) need to be added, regardless of the normative
model.

The fundamental problem is the assumption of a uniform benefit of
uniform value which is central to the societal cost effectiveness model.
This assumption is presumably made for administrative and expository
reasons, not because anyone believes that marginal health benefits are
uniform, or that the marginal value of a health benefit (to a consumer
or society) is independent of the current level of health or allocation
of resources. It was hard enough to get policymakers to accept the need
for considering costs and the need to establish a money value for health
outcomes, however arbitrary, and in the United States neither of these
concepts is as yet effective. But paradoxically it might be more
feasible to get political acceptance if more attention to reasonable
variation in effectiveness and value were explicit rather than
suppressed in the analysis. As always, there is a case to prefer
approximating the perfect rather than precisely hitting the imperfect as
a method of policy analysis.

Comment: Mark Pauly has contributed extensively to the policy
literature on the moral hazard of health insurance (the hazard that
individuals will obtain care that they do not need if they do not have
to pay for it), a concept which has been used to support cost sharing
(deductibles, co-payments and coinsurance) as a means to create consumer
price sensitivity. Pauly now expands on the concept by applying it to
cost effectiveness analysis.

With our very high health care costs, it is inevitable that more
attention will be paid to cost effectiveness. Although most cost
effectiveness analyses are aimed at whether or not a particular health
care service or product provides adequate societal value (measured
benefit per unit cost, especially costs that society pays through public
programs or private insurance), Pauly now suggests that the value to the
individual, as expressed by the level of cost sharing tolerated, should
also be introduced in determining cost effectiveness.

First, a few words about cost effectiveness. Most health care
professionals do attempt to provide cost effective care. If a very
expensive procedure likely would provide no health care value, the
practitioner would advise against its use. Likewise, low cost but high
volume interventions that are eventually shown to be ineffective also
would be abandoned by the practitioner.

Sometimes we simply don't know whether the benefit is worth the cost.
This is where cost effectiveness analysis can be helpful. If a cancer
drug regimen that costs $300,000 results in maybe three months of poorer
quality life due to side effects, but prolongs life by only three days,
most reasonable individuals would decide that this is not cost effective
and should not be paid for through our collective funds, whether
government taxes or private insurance funds. Three months of hospice is
better than three months and three days of therapeutic misery.

An example of a low cost, high volume intervention might be the use of
an anti-hypertensive drug that in long term studies showed absolutely no
benefit in reducing morbidity or mortality. Obviously that would not be
cost effective, and its use would be abandoned.

Okay. So we determine that most medical interventions fall somewhere
between 100 percent cost effective and not cost effective at all. Then
we are supposed to determine a level of cost sharing for each
intervention that would motivate the patient to make a correct decision
on whether or not to accept the care based on consumer-directed cost
effectiveness decisions that still provide adequate societal value? Come on!

Forget moral hazard. Through cost effectiveness analyses we can
determine whether or not medical interventions should be available to
patients, and we don't need to have patients making spending decisions
to determine health care value. Even if the benefit may not be uniform
between patients, the decisions should be made at the clinical level
based strictly on medical benefit and not on cost. Cost decisions should
be made at the societal level.

The purpose of cost sharing is to reduce health care spending. Our
message earlier this week demonstrated that controlling moral hazard
through cost sharing introduces behavioral hazard; that is, decisions
that patents make when exposed to out-of-pocket costs as a consequence
of accessing health care can be detrimental. Policies that promote
detrimental medical decisions are bad policies.

Keep in mind that we spend almost twice as much per capita on health
care as the United Kingdom, yet we have ever-increasing cost sharing
whereas their system pays 100 percent of the cost of covered services.
There are many features of their national health services that result in
lower costs, but one that applies to today's discussion is their
application of cost effectiveness and evidence-based analyses through
their National Institute for Health and Clinical Effectiveness (NICE).
Eliminating ineffective and detrimental care reduces costs, with a net
gain in quality.

Just think of what we could have if we established a single payer
financing system. We could reduce administrative and clinical waste
while eliminating financial barriers to care so that everyone would have
access to cost effective and evidence-based, high quality care - care
that is really NICE.